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Why a Contrarian Analyst Came Around on Bank of America

At times an outspoken critic of the top banks, analyst Mike Mayo is now bullish on the group, including Bank of America Corp. and Citigroup Inc.

U.S. stocks are little changed in late-morning trading on Friday, with the S&P 500(SNPINDEX:^GSPC) and the Dow Jones Industrial Average(DJINDICES:^DJI) (DJINDICES: $INDU) down 0.06% and 0.02%, respectively, at 11:15 a.m. ET. Citigroup Inc.(NYSE:C) is rounding out a pretty decent week for the big banks, reporting first-quarter results this morning that beat Wall Street's expectations. The stock is up 1% as of this writing.

Follow-up: Underwriters priced Bats Global Markets, Inc.'s initial public offering (IPO) yesterday at the top of the indicative range -- $19 per share. There is clearly an appetite for shares of the exchange operator. You can read my thoughts about the stock here.

It turns out that the headline was false, but it did the job. In fact, the analyst never said that, nor anything like it. However, clicking on the link was not a complete waste of time, because the analyst in question turned out to be Mike Mayo.

Mayo is an outspoken voice in the analyst community, and he's willing to stand apart from the herd. He doesn't work for one of the bulge bracket firms (he works for CLSA, part of Credit Agricole SA). In 2011, he published a book. The title: Exile on Wall Street: One analyst's fight to save the big banks from themselves. He's the only analyst I know who talks more like an activist investor.

So, naturally, when I hear that Mayo is positive on banks, I'm interested to hear his views.

Appearing on CNBC yesterday, here's what he had to say about the top four U.S. banks, JPMorgan Chase & Co.(NYSE:JPM), Bank of America Corp.(NYSE:BAC), Citigroup Inc., and Wells Fargo & Co.(NYSE:WFC)as a group:

The quality of loans, even with energy -- it's fine. Book value is still growing. These are resilient banks, they're banks that are becoming more efficient, one way or another and the valuations are pricing in levels that were seen... recessions of two thousand...

In other words, you've got institutions that continue to improve that are trading at depressed valuations -- an interesting combination.

The CNBC host then pressed him on where the upside would come from. Not an unreasonable question, as bank valuations have been depressed for some time. Mayo's response:

Revenues have been lousy the last three years. As bad as revenues were, they should be better the next couple years. As bad as efficiency's been, efficiency should be better the next few years. And the risk? You can charge off another housing crisis over the next five years and still have more capital than you had before the last downturn.

So how does Mayo rank the different banks in the group?

We need to keep some perspective here, so JPMorgan and Wells Fargo are the 'A' and 'B' students. Citigroup is a 'D' student that we think will become a 'B-' student, so going from a 'D' student to a 'B-' student that creates a lot of upside. And you saw yesterday, Citigroup was the only one of the large eight banks that got an effective pass on their living will.

In other words, JPMorgan and Wells are the best-quality franchises, but Citigroup has the greatest margin for improvement (Citigroup's stock also trades at the lowest multiples in the group). What about B of A?

We recommend Bank of America for the first time in several years... As much as I hate their oversight, I hate the lack of accountability from management. I love their balance sheet, I love their franchise, I love their growth in book value, I still put Citigroup above them.

Translation: Bank of America, despite poor governance, is a better business than Citi, but the shares have less upside.

I have been pounding the table on some of these banks for several months (here, here and here, for example), but don't take my or Mayo's word for it -- do your own due diligence.

Oh, and the "most bullish in twenty years"? It refers to Mayo's upgrade of Comerica Incorporated for the first time in 20 years. Mayo thinks Comerica is ripe for a restructuring or as an acquisition target.